Hubris E-Book

Ray Perman

• Herausgeber: Birlinn
• Kategorie: Geisteswissenschaft
• Sprache: Englisch

Seitenzahl: 529

Veröffentlichungsjahr: 2013

Beschreibung

In 1995 Bank of Scotland celebrated 300 years as Britain's oldest commercial bank. Voted 'most admired bank', respected by competitors, applauded by investors and trusted by customers, it looked forward to the next three hundred. Less than 15 years later it was bust, reviled as part of the spectacular collapse of HBOS, the conglomerate it had joined. One of the high-profile victims of the credit crunch, its spectacular fall caused seismic shock waves throughout the financial world. What went wrong? Ray Perman, who has followed the Bank since the 1970s when he was a Financial Times journalist, uncovered the story from documents and dozens of interviews with people at the top in Bank of Scotland and HBOS - from being the bank of choice for the highrolling Monte Carlo mega-rich to losing GBP10 billion. It is a cautionary tale for our times. In the complex world of modern global finance, the brilliant men who ran the company ignored the simple banking rules that their predecessors learned the hard way three centuries before.

Leseprobe

HUBRIS

Ray Perman was a journalist in London and Edinburgh for thirty years. He was a co-founder of the business magazine Insider Publications and was Chief Executive of Scottish Financial Enterprise from 1999 to 2003. In 2011 he was appointed Chairman of the James Hutton Institute, the first institute of its type in Europe dedicated to making new contributions to the understanding of key global issues such as food, energy and environmental security.

This eBook edition published in 2013 by Birlinn Limited West Newington House Newington Road Edinburgh EH9 1QSwww.birlinn.co.uk

First published in 2012 by Birlinn Limited

Copyright © Ray Perman, 2012, 2013 Foreword copyright © Alistair Darling, 2012

The moral right of Ray Perman to be identified as the author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988

All rights reserved. No part of this publication may be reproduced, stored or transmitted in any form without the express written permission of the publisher.

Print ISBN: 978-1-78027-132-3 eBook ISBN: 978-0-85790-229-0

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library

Version 2.0

‘In the eye of the storm, Nemesis followed Hubris’

Lord Stevenson of Coddingham,

Contents

List of Illustrations

Foreword

Preface

Preface to the Paperback Edition

1 Banker to the Stars

2 Base metal into gold

3 A cosy world

4 Cometh the hour, cometh the man

5 The Cultural Revolution

6 The most boring bank in Britain

7 A dark land – we need to pray for them

8 No turning back at Derby

9 Morituri te salutant

10 ‘The next thing he does has got to work, otherwise he’s toast’

11 Peter’s Last Supper

12 A clash of cultures

13 Room at the top

14 Give me enough debt and I’ll move the world

15 As safe as houses

16 Ziggy’s stardust

17 The eye of the storm

18 Apocalypse now

19 Nemesis strikes

20 Hungry for risk

21 Why didn’t they realise?

22 The drive for profit at any price

23 Why didn’t the regulators stop HBOS?

24 The end of history

25 Gone, but not forgotten

26 Called to account – at last

27 Retribution of a sort

Notes & references

Bibliography

Index

List of Illustrations

Sir Walter Scott broods before the former Bank of Scotland headquarters in Edinburgh.

Covenant Close, off Edinburgh’s Royal Mile, once housed the Cross Keys Tavern, where in 1695 shareholders first subscribed for Bank of Scotland shares.

An early Bank of Scotland note.

The Bank of Scotland board in 1995.

The Bank of Scotland crest outside The Mound.

Peter Burt and Halifax’s James Crosby announce the merger which formed HBOS in 2001.

Gordon McQueen, Peter Burt and George Mitchell.

George Mitchell.

The HBOS board in 2006 in the old Bank headquarters.

Peter Cummings.

The former Bank of Scotland headquarters on the Mound.

Sir Philip Green.

Vincent Tchenguiz, one of the high-rolling ‘FOPs’ (friends of Philip Green).

Former Rangers Football Club owner Sir David Murray.

Tom Hunter.

Graeme Shankland, one of Peter Cummings’ key lieutenants.

Andy Hornby with Lloyds’ chairman, Sir Victor Blank.

Foreword

My years in the Treasury during the financial collapse of 2007–8 gave me more hands-on practice dealing with banks than any Chancellor of the Exchequer in living memory. During frequent increasingly tense meetings I also came face to face with the men running those institutions. It is not an experience I would recommend. Northern Rock was the first British casualty of a storm which was to engulf dozens of banks in the US and Europe, but in August 2007, when I asked for a list from my officials of other banks that might be exposed to the US market, HBOS was there.

This is a story about the downfall of one bank, but it is more than that. The consequences of the 2008 banking collapse in Scotland, the UK and in Europe have proved catastrophic. The economic crisis that resulted threatens years of stagnation, with little growth, high unemployment and lost opportunities. How could it happen? We need to understand that to know what lessons to draw from it.

The headquarters of the Bank of Scotland on the Mound dominated the Edinburgh skyline for centuries. It was a symbol of strength. The Bank of Scotland, founded in 1695, had come to represent all that was best in Scottish financial acumen. It began lending money to the Scottish nobility with loans secured on good quality land. It understood the risks it undertook and it prospered. By the late 20th century it was seen as a solidly sound if unexciting bank. Then, in the late 1990s, the bank made the decision to merge with the Halifax Building Society to form HBOS. The Halifax was Britain’s biggest building society. It too had prospered. But this was a marriage made on the rebound.

The Bank of Scotland had decided to pursue the takeover of the National Westminster Bank, one of the UK’s biggest banks which was viewed as under-performing No sooner had it done so than its old rival, the Royal Bank of Scotland, entered the fray. The Royal Bank pursued an aggressive campaign to win Nat West, judging that whichever bank seized the prize would establish itself as a dominant UK presence. The Royal Bank won. Shortly afterwards, the Bank of Scotland felt exposed. Having lost the bid it could not afford to stand still – hence the merger with the Halifax.

The new bank was now under a different management style. It began to pursue an aggressive lending policy to personal and business customers. In particular it pursued a policy of expanding its market share in the domestic mortgage market and also started lending billions of pounds for commercial property. It was taking on risks that it did not understand. By 2008, as the global banking crisis took hold, HBOS found itself hopelessly over-exposed and facing collapse. It had no option but to agree to a takeover by Lloyds Bank in September of that year.

HBOS was not alone in lending billions of pounds on the back of rapidly rising house prices and a property market which seemed to promise limitless returns. In Ireland, the banks were similarly exposed. So too was HBOS and RBS, through its subsidiary Ulster Bank. The sheer scale of the losses incurred by the Irish banks were to bring down the Irish government which was forced to go to the International Monetary Fund and to fellow eurozone members for a bail out. A similar property bubble left many Spanish banks in a similar state, forcing the Spanish government to seek almost 100 billion euros from eurozone members in the summer of 2012. Other banks too, particularly in continental Europe, remained fearful that the continuing economic downturn would result in many of their loans turning bad, leaving them with losses.

Although it is easy now to identify what went wrong, no regulator anywhere in the world picked up on the growing risks the banking system faced in the mid part of the last decade. But the warning signs were there. Indeed many of the symptoms were spotted, but nowhere did anyone bring together all the warning signs before disaster struck. In particular, the trade in sophisticated financial products which brought down many US banks and RBS here in the UK were not fully understood by the banks themselves. There seemed to be an assumption that if everyone was making money from these trades that they must be all right. Very few were prepared to ask themselves what exactly these products were worth. The answer was very little.

Primary responsibility must rest with the boards of these banks. The board of a company has a legal responsibility to its shareholders. Board members should have asked themselves whether they understood the risks to which the bank had become exposed. In lending such huge sums they should have asked themselves what would happen if the borrowers got into trouble and could not repay the debt. This is not rocket science, it is basic banking and as this book shows, it used to be second nature to bankers and to bank boards.

The regulators for their part failed to understand just how exposed some of these banks had become. Worse, they did not appreciate how interconnected the world’s banking system had become. They looked at each bank on its own. They did not ask what would happen if a bank got into trouble, perhaps on the other side of the world and how its problems would spread rapidly through the global banking system. Northern Rock was a well-established provincial building society with deep roots in the north east of England. It had, along with a number of other building societies, demutualised in the 1980s to become banks. During the course of the crisis every single building society that demutualised either failed or had to be taken over. It is instructive to see what happened in the case of Northern Rock.

When building societies were first set up they had a simple model. They took in money from hard-working artisans who in turn borrowed money when they wanted to buy a house. But in the 1990s and in the decade that followed a new model emerged. Banks discovered they could borrow money from other financial institutions across the globe and in particular in the US. The money there was to a large extent generated by the trade of sophisticated financial products, many based on what is now known as the ‘sub-prime mortgage market’, involving home loans to people on low incomes, secured on property of little or no value. It was inevitable borrowers would eventually default, and so they did, on an industrial scale. When the crash happened, the money that Northern Rock relied on from this wholesale market dried up and the bank rapidly became insolvent.

It was not just the former building societies that got into trouble. HBOS too had followed a policy of expansion based on lending substantial sums of money to as many people as possible. It was a classic case of pile ’em high, sell ’em cheap. For a bank this was disastrous.

That was bad enough in itself, but what the regulators failed to foresee were the consequences of banks being so dependent on each other for cash. They routinely lend billions of pounds to each other overnight and over long periods – perhaps six months or even two years. What happened at the end of 2007 was that as banks realised how exposed they were to other banks which had done exactly the same thing, they took fright and refused to lend to each other. The consequences were catastrophic.

So another big lesson for the future is that it is not good enough to judge the health of a bank by simply looking at its own position. Rather, regulators have to ask: what are the consequences of another bank failure, perhaps in another part of the world.

The economic, social and political consequences of a banking collapse mean there is a real public interest in what goes on in a bank. A noticeable feature of my tours of the country to speak about my own book (Back from the Brink, published by Atlantic Books in 2011), was the understandable concern and knowledge expressed by my questioners. Regulators cannot stand in the shoes of each bank manager and impose their judgement every time a loan is made, but they can insist that banks carry more capital in reserve as a safety cushion, and that the business is organised in such a way that in the event of a crisis it can be broken up or at least managed through it.

There is an argument that some banks are too big to be allowed to fail, so they should not be allowed to exceed a certain size. The problem with this is that in the event of a crisis no bank, no matter how small, can be allowed to fail. The risk is that if one bank goes, people will immediately ask: who is next? That is why we had to step in to deal with the Dunfermline Building Society when it collapsed in 2009. Under new legislation we were able to transfer it to the Nationwide Building Society.

In more tranquil economic times of course a bank, like any other business, can be allowed to fail. It happened with Barings and BCCI in the 1990s. And we must get to a situation where those who gain from a profitable bank share the losses when it goes wrong. But this will take time. So regulation needs to be tightened up, it must be more intrusive and there has to be far greater international co-operation between regulators.

As I write this, in the summer of 2012, the banking crisis is far from over. In the US and in the UK we cleaned out the banking system in 2008 when the crisis struck. Different mechanisms were used, but the bad debts and the toxic assets were identified and dealt with. More capital was put into the banks, and in the case of the UK, the government acquired major shareholdings in RBS and the Lloyds group.

In Ireland too, the government removed these bad assets from their banks. But there was a terrible cost as the banks were far bigger than the Irish state. When the bank debts became Ireland’s debts, the country was brought to its knees. There is an important point here. In the future, people will look very closely at who stands behind financial institutions. To put it bluntly, does that country have enough money to bail out any bank that needs it? Banks that grow too big for the country they are based in pose a serious threat. In the last decade the Scottish National Party used to boast of an ‘arc of prosperity’, including Iceland and Ireland. They wanted Scotland to be part of it. We don’t hear much talk of that now.

Unless and until the eurozone ensures its banks are cleaned up we will not get economic recovery. Spanish banks are exposed hugely to a collapsed property market. In turn the problems in Greece and Italy run the risk of defaults that could hit larger French and German banks. The inter-connections are still there and could still prove fatal.

The story of HBOS is salutary. Surely it is a classic case of trying to fly too close to the sun. The bank took on risks it did not understand and failed to make provision for. The result is that the name may exist but it is not the bank it was. A walk around the former headquarters on the Mound is a depressing experience. The building is more museum than the beating heart of the self-confident and prosperous bank it once was.

Alistair Darling

25 June 2012

Preface

In the autumn of 2008 I attended a black tie business dinner. I forget the occasion or the organisation responsible, they are all very similar and after a while the memories of each merge into one. Next to me at the table was a man with whom I had little in common. He managed a commercial real estate company and, although he took a keen interest in the collapse of the property market then in free fall, it did not directly affect him. His portfolio was mature with established tenants paying good rents. I only half listened to his conversation, nodding and smiling occasionally so as not to appear too rude. Then he said something which seized my attention: ‘I withdrew £20 million today from Bank of Scotland to put it in a safe place.’

There had been rumours for days swirling around HBOS, the unlovely conglomerate which now owned the Bank. (‘The Bank’, with an initial capital letter, might mean the Bank of England south of the border, but north of Berwick and Carlisle it had always meant Bank of Scotland). It was clearly in trouble, but the thought that it might go down, taking its depositors’ money with it had never occurred to me and came as a real shock. The Bank had been part of the Scottish landscape for more than 300 years, as solid and as tangible as the rock on which Edinburgh Castle stood. My wife and I had entrusted our savings to it. My sons had been Bank of Scotland customers since we opened Super Squirrel saver accounts for them as toddlers. The Bank had supported my own company – and countless other new start businesses – through thick and thin and when I sold it, that’s where I deposited the proceeds.

Now it was also banker to another small business I chaired. We had not been in business as long as my dinner companion and we did not have £20 million, but we had a substantial sum on deposit, hard-earned money which was keeping us safe through the recession. Britain had already seen the first run on a bank for 70 years. Unsettling television pictures of queues of savers waiting to withdraw their cash had spooked ministers and helped to hasten the end of Northern Rock. I had no wish to do even a small part in pushing Bank of Scotland down the same path, but our company could not afford to lose that money, nor see it tied up in administration or liquidation proceedings for months or even years. I called my company’s chief executive the following morning and told him to open an account in a safer bank and transfer the money immediately. When I called him later in the day his news was not encouraging. It had taken him hours to get through on the telephone and when he did it was to be told that because of the volume of new accounts being opened, it could be days or even a week before our application was considered. The rush away from the Bank was headlong.

What happened to HBOS in the weeks following is part of this story, but only part. The excesses of bankers during the first decade of the twenty-first century are lurid enough to grip the interest of readers, but to dwell too long on them would be to lose sight of what we have lost. The Bank of Scotland which all but disappeared with the collapse of HBOS was not the same Bank that I and many of its customers knew in the last few decades of the last century – and bears no resemblance to the institution behind the Bank of Scotland name which is still over the frontage of hundreds of bank branches – merely another brand of the massive Lloyds Banking Group.

The Bank whose story I want to tell was quantitatively different to banks operating now. It was not insubstantial, it was after all a FTSE 100 company – one of the biggest companies on the stock market. But it was a fraction of the size of banks today and operated on a human scale. Customers could telephone branches and speak to people whose names they knew and faces they recognised. If you called back, you could speak to the same person. For Bank of Scotland managers ‘know your customer’ did not mean look at a computer screen, but recognise their names, remember their banking history, their businesses and perhaps their families too. A human scale meant that the chief executive could review all large lending propositions and all customer complaints, replying to them personally if he felt they had not been adequately answered.

This was a bank which never called you at dinner time to try to sell you ‘products’. Thirty years ago when I began my relationship with it, the Bank took the view that if you needed its services you would ask. Later its managers were encouraged to try to sell to customers, but it was never pushy and sometimes they looked rather embarrassed in doing so. It seems incredible to me to write this now, but it was a bank which was trusted by its customers. When it adopted the advertising slogan ‘A Friend for Life’ it was not greeted with cynicism. People believed it meant it, and more importantly, it did.

To say the Bank was rooted in the community is an understatement. It had been part of Scottish history since before the Act of Union and there was no major historical event since in which it had not played a part. It acted as banker to a large proportion of the country’s employers and their employees. It banked charities and community groups, golf clubs and trade unions. It looked after the millions of some of Scotland’s richest men and women, but was also one of the first banks in the UK to offer bank accounts for all in disadvantaged communities. When The Big Issue wanted to open accounts for its homeless magazine sellers to deposit the cash they collected, the Bank’s Treasurer defied the money-laundering regulation which said that a bank had to verify the home address of all its customers and opened them all with the address of one of the Bank’s branches.

Don’t get the impression that this was some hick bank. It was one of the most innovative in the world, the first to bring electronic banking to Britain, a leader in leveraged finance back in the days when those were not dirty words, the first clearing bank to get its cost/income ratio below 50 per cent and a pioneer in getting others to sell its services so that it could extend its reach further than bricks and mortar would allow. It was at the same time a risk taker, known for backing entrepreneurs, and a prudent institution, maintaining high capital ratios. And it became the best-performing bank in Britain in terms of its return on equity. Its share price quadrupled in ten years.

Bank of Scotland was not unique. Many of its characteristics were shared by the other Scottish banks, The Royal Bank of Scotland and Clydesdale Bank, and they had once been replicated across the UK. But with the exception of Yorkshire, which kept its bank longer than most, other regions lost their financial institutions to a relentless process of consolidation during the twentieth century, which shrank competition and extinguished local responsiveness.

Bank managers used to be among the most respected in their communities – and they were in the community because managers managed branches and branches were part of the fabric of small towns or city neighbourhoods. With the local clergyman and the school teacher, the bank manager was trusted to sign the back of your passport photograph or give you a character reference when you went for your first job. A retired manager writing in the Bank of Scotland staff magazine noted how ‘Bank men’ usually ended up as the treasurer of the golf club, the church committee or the parent-teacher association. I suspect that was once true of all bank managers anywhere in the UK – people knew the cash was safe with them. Part of the branch manager’s standing came because he (almost invariably ‘he’) could make real decisions. He could agree a personal loan or business overdraft and he made his decision not only on the basis of working out the figures, but also on his assessment of character based on years of local knowledge. Only in the case of large amounts would he need to get sanction from Head Office, which took into account his recommendation and the fact that since he was likely to be in post for years at a time, he would have to live with the consequences if the decision turned out to be the wrong one.

Now many thousands of branches across Britain have been closed and those that are left are manned by ‘relationship managers’, who probably do not live locally, do not have time after the stress of work to be treasurer of anything and will not be in post long enough to build a relationship with anyone or any business. Face-to-face meetings have given way to call centres, risk assessment to credit scoring. Personal recommendation has been replaced by ‘customer acquisition’, services replaced by ‘products’ sold to reach targets, rather than to answer the needs of customers. As recent fines imposed on the big banks by the regulator have shown, some products were ‘toxic’ – they did the customers who bought them more harm than good – and in some cases the banks knew this before they sold them. To meet constantly rising profit expectations, big banks have continually to drive down cost – mostly at the expense of customer service and satisfaction – and expand their sales, often by swallowing other companies to gain their customers. At each stage banks became more remote from their customers, geographically and by hiding behind automated telephone systems. What has been lost in this process is trust.

This is the story of how one bank went from being one of the most trusted, to one from which customers could not wait to remove their money.

I am grateful to all those current and past executives of Bank of Scotland and HBOS who have spoken to me. Many asked for anonimity, so I feel it invidious to name those who did not. Where I have attributed quotes to individuals, their words were already on the record, either in newspapers and magazines or company or Government reports. There were also many who would not speak to me. As I say later in this story, I do not criticise them for that; I have no right to demand their response, but it does mean that I have not been able to check facts with them. I am grateful to those who considered my request for an interview and then wrote to decline. Several did not give me the courtesy of a response.

I have tried to report only actions and not to attribute motives without evidence. I have also tried not to apportion blame. Readers should make up their own minds.

Preface to the Paperback Edition

In the summer of 2012 a new scandal engulfed British banking. The collapses and rescues of 2008–9 had precipitated the deepest economic downturn for eighty years; banks were still having to pay billions of pounds in compensation for mis-selling Payment Protection Insurance; and there was public outrage over continuing high levels of salaries and bonuses. The revelation that LIBOR interest rates were being manipulated was the last straw. Regulators on both sides of the Atlantic imposed fines running into hundreds of millions of dollars and pounds on several banks and there was a clamour in the UK for a judge-led public inquiry into the whole industry.

The Government’s response in establishing a Parliamentary Commission on Banking Standards was seen by some critics as a craven second-best. In the event the commission proved to be anything but a creature of either the still-powerful banking lobby or the Government. It was led by the Conservative MP Andrew Tyrie, chair of the Treasury Select Committee, and recruited its members from both houses of parliament. Drawn from all parties and none, they included political heavyweights like former Chancellor Lord Nigel Lawson and the former Treasury Committee chair Lord John McFall. There was also the former Cabinet Secretary Lord Andrew Turnbull and, to the surprise of many, Justin Welby, once an oil trader, then Bishop of Durham and soon to be announced as the next Archbishop of Canterbury.

The commission had powers to summon witnesses, obtain from the banks and the Financial Services Authority (FSA) papers which otherwise would have remained secret. It broke new ground in engaging counsel to question witnesses. It worked quickly and showed its independence with its first report, which went considerably further than Government policy in calling for the separation of domestic and investment banking. Significantly, it launched an inquiry into the collapse of HBOS, forcing directors and managers of the bank and the regulatory authority to give evidence in public.

The purpose of the inquiry was officially to ‘learn lessons’ from the HBOS debacle, but it also tapped into a simmering public anger that there had been no proper explanation for a disaster which had cost taxpayers £20 billion, seen over 2 million small shareholders lose most of their investment and would deprive 40,000 employees of their jobs. Worse, the men at the top of the Bank had appeared to walk away without sanction. They had not been named and shamed, let alone prosecuted, no bonuses had been clawed back, and the principal players had gone on to other well-paid and prestigious jobs, some in financial services. The FSA, which was supposed to regulate the industry, had produced a report blaming one man, corporate banking director Peter Cummings. A promised more comprehensive report was so long delayed that the FSA was abolished before it was published.

For those affected by the HBOS disaster, the commission’s public examinations became compulsive viewing on parliamentary television. They also received widespread attention from press and broadcasting. At last people were being held to account. I wrote in my preface to the first edition of this book that I had tried not to apportion blame. The parliamentary commission had no such inhibitions, and An Accident Waiting to Happen, its report on the collapse of HBOS, published in April 2013, provoked a storm of public indignation against the men who had led the Bank – the chairman Lord Stevenson and the two chief executives, Sir James Crosby and his successor Andy Hornby.

The report itself was comprehensive, detailed and damning. But although the commission was able to cross-examine some witnesses who had refused to speak to me, and to obtain board minutes and other corporate documents which I was denied, its conclusions were no different from mine. I have therefore left the main narrative of the book, which covers a longer period than the parliamentary report, unchanged, and I detail and analyse its findings and their implications in new final chapters to this edition. Since this book first came out, many former HBOS employees have contacted me, and I include some of their stories in the new chapters.

It is a sorry tale: how human weakness and pride destroyed two solid and once-respected institutions. We need to know the story, but is that enough to prevent it happening again?

Edinburgh

June 2013

1

Banker to the Stars

The family of retail billionaire Philip Green knows how to throw a party. For his 50th birthday the tycoon’s wife Tina organised a three-day bash in Cyprus which reportedly cost £5 million. Rod Stewart and Tom Jones provided the music, the guests were expected to wear togas and the birthday boy himself dressed as the Emperor Nero. The tycoon’s 55th was even more exotic, with the Greens flying 100 guests 8,500 miles in two private jets to an eco-spa on a private island in the Maldives, where singers Ricky Martin and George Michael performed.

There were no togas for son Brandon’s bar mitzvah in 2005, but no expense was spared nonetheless. The Greens took over all 44 rooms and nine suites of the Grand Hotel on Cap Ferrat, one of the most luxurious and expensive hotels in the South of France. Rooms can cost up to £1,000 a night, but The Sunday Telegraph speculated that the Greens would have paid much more to ensure exclusivity at a time when the hotel could expect to be busy with stars attending the Cannes film festival1. In addition to its Michelin-starred food and extensive cellar, including rare vintages of Château d’Yquem from 1854 and Château Lafite Rothschild from 1799, the hotel boasts an auditorium with outstanding acoustics designed by Gustave Eiffel, of tower fame. It was not big enough for the Greens’ party of 200 so they built their own. A synagogue is also an essential part of a Jewish boy’s coming of age and the hotel did not have one, so that was constructed too. These weren’t flimsy structures. So much wood and stone was used that guests marvelled that the buildings were only temporary.

Some guests arrived in the charter flight from London laid on by the Greens, others came from nearby Monaco in a fleet of luxury cars and a few in their own speedboats. It was a private party and locals moaned that public footpaths around the hotel had been closed for the event, but paparazzi lurked under the Aleppo pines in the grounds, or behind rocks on the Mediterranean shore to snap celebrities such as television impresario Simon Cowell, pop star Beyoncé, who was providing part of the entertainment, racing driver Eddie Jordan and film director Michael Winner. From the world of business came Tom Hunter, the Scottish entrepreneur, Royal Mail chairman Allan Leighton and the property-developer brothers Robert and Vincent Tchenguiz. There were also the high-powered international investment bankers who had part-financed Philip Green’s string of acquisitions of high street fashion chains – Mike ‘Woody’ Sherwood, top banker in the UK for the mighty Goldman Sachs and worth a reputed $48 million2, and Bob Wigley, Chairman of Merrill Lynch in Europe.

And there was Peter Cummings.

Short, balding and smartly dressed in black tie, Cummings looked no different to many of the business people present, but he was not like them. He had been educated at St Patrick’s High School, Dumbarton, not expensive private schools like Sherwood and Wigley. He did not own his own yacht like Green and Hunter, although he counted scuba-diving as one of his hobbies. He did not have an apartment in Monaco – in fact he still lived in the modest semidetached home he had bought with his teacher wife Margaret in the town in which he was born and went to school. He had a reputation among those who knew him well for being quiet, thoughtful and meticulous. He gave to charities – the Maggie cancer support centres and a school in Malawi, which he was quietly co-funding with his wife – but not in the ostentatious way of some of the millionaire philanthropists at the Riviera party. He was a banker, but not for one of the glamorous Wall Street investment houses like Goldman or Merrill and his had not been a quick rise to the top.

After school Cummings had taken the path many bright kids had chosen in an age when university entrance was only considered for the fortunate few. He had joined Bank of Scotland as a trainee and studied at night for his banking diploma. The Bank moved him around – unspectacular jobs, but he broadened his experience and steadily climbed the hierarchy: regional manager in Carlisle, manager of the Glasgow Chief Office, head of corporate recovery, director of corporate banking. His experience had also given him something many of his younger competitors lacked. He had worked through three recessions as well as the prolonged boom of the first decade of the twenty-first century.

Among other bankers he was envied, despite his unglamorous early career. No one had a closer relationship or had been able to pull off such big deals with Philip Green. Bank of Scotland had backed Green through a succession of larger and larger buys, culminating in the purchase of the Arcadia group in 2002 which had brought him household names such as Burton, Dorothy Perkins, Evans, Wallis, Miss Selfridge and Top Shop. Green borrowed more than £800 million to secure the deal, but paid it all back in two years. The Bank earned handsome fees and huge kudos, but there was more. Green allowed Cummings to buy a small shareholding in the business for the Bank, a privilege given to no one else. When Green paid his wife the biggest personal dividend in UK corporate history a year later, the Bank made £100 million profit – one hundred times what its stake had cost.

On the strength of his relationship with Green, Cummings had been able to meet and work with entrepreneurs like Tom Hunter, the Tchenguiz brothers, hotelier Rocco Forte and property magnate Nick Leslau. These were the high rollers, the guys who did the big deals and were fêted by the press. Newspapers began to call him ‘Banker to the Stars’ and within HBOS, the conglomerate which Bank of Scotland had joined in 2001, he was seen as a star in his own right, responsible for a growing proportion of the group profits. The Bank commanded respect and admiration far beyond its size and modest roots and rivals wanted some of the action. Cummings had turned down several lucrative job offers from international investment banks, but when he ‘sold down’ his deals – reducing risk by offering part of the loan to other banks – there was no shortage of takers.

The bank Peter Cummings joined had been very different to the one of which he became a director 35 years later. Then it had been an institution with modest ambitions with, some would have said, a lot to be modest about. It was not even the biggest bank in Scotland let alone being taken seriously as a challenger on a UK scale. It was conscious of the weight of history on its shoulders, conservative in its outlook and particular about the people with whom it did business. There was an instinctive distrust in the Bank for anyone regarded as ‘flashy’.

The thought that one of its senior managers might be seen in the same company as men and women who appeared regularly in the gossip columns of the cheaper newspapers and magazines would have filled the directors of 30 years ago with horror. When he had been making the tea in the Dumbarton branch, Cummings cannot have dreamed that years later he would be sipping Louis Roederer Cristal Vintage Champagne in such exalted company on the Côte d’Azur. Nor that his bosses would have thanked him for it and assured him it was part of the job.

Nor can he have foreseen that a few years later his star would have fallen so precipitately. His bank would be scorned for its overweening ambition and short-sighted risk-taking. Newspapers would accuse him of bringing down his bank almost single-handedly and call him ‘the banker of last resort’ – the man who lent money when everyone else was too sensible to do so. Associates who previously wanted to get close to him would now give anonymous quotes to journalists saying that all along they had thought he had been too aggressive and taken too many chances. The financial regulator, which had given his bank a clean bill of health, would pursue him to admit to things he had never believed he had done.

How had it happened?

2

Base metal into gold

To understand why the Bank met the end that it did, I went back to its beginning. We live in turbulent times but they are not unique. The era into which Bank of Scotland was born at the end of the seventeenth century shared a remarkable number of characteristics with the first years of the twenty-first. A long-standing political dynasty had recently come to an end. One head of government (in this case the monarch, Charles II – not universally liked, but with a deft enough touch to ensure his survival) was replaced by his unpopular brother, James II, who lost his throne in short order. The new leader who deposed him, young and fresh-faced William III, announced a power-sharing agreement, although a co-regency with his wife Mary rather than a coalition. The first years of their reign were marked by unrest at home and expensive wars abroad. To pay for them, the Government borrowed heavily, depressing the economy. Does it sound familiar?

The end of the seventeenth and start of the eighteenth centuries was an Age of Reason and an age of science. The philosopher René Descartes was not long dead and John Locke was laying the ground for modern political thought. Isaac Newton, one of the greatest scientists and mathematicians of all time, was at the height of his powers and Robert Boyle had published the treatise which was to lay the foundations of modern chemistry. New discoveries were being made in every field and examined in literature and debate. Alongside science and mathematics there was a new interest in economics and the disciplines of banking, finance and accounting as mechanisms for expanding trade and economic well-being. Yet despite the spread of rational thought, belief in magic was still strong. In Salem, Massachusetts, they were hanging witches. In Europe the study of the occult was a respectable intellectual pursuit. Newton himself was deeply interested in alchemy and the quest for the mythical Philosopher’s Stone, which was said to be able to turn base metal into gold. Among the financial rationalists there were also alchemists – men who saw banking as a way of creating profit from nothing – another parallel with our own era.

Scotland in the 1690s was still nominally an independent country with its own parliament and institutions, although it had shared a monarch with England since James VI of Scotland had succeeded Elizabeth I in 1603. The relationship between the two countries was ambivalent. Many Scots had followed the king to London and played important parts in the city’s life and commerce, but Scottish goods still faced high tariffs when imported into England. Scotland was decidedly the smaller and the poorer partner. Its population, at about a million, was a fifth of the size of its southern neighbour and its economy was much less developed, relying heavily on agriculture and natural resources like coal.1 This became apparent when a series of bad harvests brought famine and hardship at home and reduced the surpluses available for export. Importantly, Scotland also had a much weaker and more fragmented financial system, which restricted credit and cramped growth.

The renaissance states of northern Italy had developed banking in the fourteenth and fifteenth centuries, and the Netherlands, the leading financial power of the seventeenth century, had established the Bank of Amsterdam in 1609, but before 1694 neither Scotland nor England had banks. There were bankers, wealthy landowners or merchants who lent money at interest, but they acted as individuals rather than in organised companies. Goldsmiths were especially prominent and had their booths around the cathedral of St Giles in Edinburgh.2 The most famous was George Heriot, known as ‘Jingling Geordie’, a prosperous smith who became both jeweller and banker to the court of James VI and followed his best customer to London in 1603. Churches sometimes also lent money: the elders of Alyth Church, Strathmore, Perthshire, a prosperous village at the meeting point of several drovers’ roads, charged 4–6 per cent on their loans and members of the congregation who were late in meeting their repayments could expect to be denounced from the pulpit.3 But those able to lend money and those able to borrow it, were the exception rather than the rule. Credit was hard to come by.

To make matters worse, Scotland and England were short of coin; there simply was not enough gold and silver to go round. William III took much of what was available to pay his armies fighting Continental wars, leaving a less than adequate supply for merchants and entrepreneurs who needed ready money to expand their trades. As an alternative, barter and payment in kind were often used to settle domestic debts – tenants paying their rents for example – and Scots merchants paying for purchases from England or abroad or receiving payment for goods sold, used bills of exchange, essentially IOUs. The weakness of the Scottish economy, however, meant that Scottish bills were often discounted in London – by as much as 10–15 per cent in bad times.4 Clearly there was a need for banks.

It is an irony that has often been remarked that a Scotsman was a prime mover in the establishment of the Bank of England in 1694 and an Englishman was the first Governor of the Bank of Scotland a year later. But their nationality was not the most important distinction; they had very different backgrounds, very different temperaments and left very different legacies to history.

The Scot was William Paterson, who was born in rural Dumfriesshire in 1658 to parents who were small tenant farmers. Not much is certain about his early life; by some accounts he moved to England at a young age, but others have him living with his parents until the age of 17, then moving to Bristol and later to the West Indies. One of his most recent biographers places him as a young man in Port Royal, a British colony in Jamaica rivalling Boston in size and importance as the largest city in the Americas, but also a nest of pirates ruled over by the notorious Captain Morgan. There Paterson is said to have first dreamed of the riches of Central America.5 However colourful this part of his life may have been, we do know that by his mid-twenties he was in London making his way in business.

He bought his way into the Merchant Taylors’ Company, one of the 12 medieval guilds of the City of London and in 1689, at the age of 31, was ‘admitted to its livery’, giving him a position of respectability, contacts and influence. He had already buried a first wife, but by now had married again and had a child. We cannot be sure what he looked like; an etching in the National Portrait Gallery, London, shows a rather sharp-nosed, haughty face beneath a full periwig. But other contemporary pictures show him in profile with a softer, more thoughtful look. He was God-fearing, a lifelong teetotaller, of modest habits, although not a Puritan.

Paterson was clearly clever and he was a thinker who published numerous essays and articles on economic and financial matters. He would later be hailed as a visionary with ideas well before his time, but he had a more sinister side too. His entry in the Dictionary of National Biography describes him as gaining ‘a reputation for double-dealing and insincerity, as well earned as that for imagination and persuasiveness’.6 One contemporary was blunter, describing him as ‘one who converses in darkness and loves not to bring his deeds into the light’.7 Others were more kind in their assessment: ‘He trusted people he should not have trusted and lacked any sense of humour.’8 He was a serious man, who never told a joke or a funny story.

Wartime shortages always provide opportunities for spivs and speculators and Paterson, although there is no evidence that he ever acted illegally, seemed to have some of the characteristics of both. The main shortage that King William’s foreign wars created was money. The monarch needed cash to pay his troops and supply his armies and Paterson saw an opportunity to supply it and make a profit.

He realised that there was money to be made by setting up a bank specifically to lend to the king and his government and, by persuading Parliament, to guarantee the interest payments from taxes. He was also quicker than most to understand that by issuing notes – promises to pay in coin if the note was presented – the bank could expand the money supply beyond the amount of cash it actually held. Provided the bank could inspire enough confidence to prevent all holders of its notes from demanding payment at the same time, it could go on creating credit indefinitely. This was not an original thought, it is one of the basic principles of banking and a number of English pamphleteers had been proposing schemes for banks for years. But previous theorists had concentrated on the effect bank credit would have on commerce and general economic growth. Paterson was much more interested in the profit it could bring to the bank and its owners. By lending the credit it created it could earn interest. He wrote: ‘The bank hath benefit of interest on all moneys which it creates out of nothing.’

Other schemes had been tried and failed. Paterson’s masterstroke was seeing how it could be applied in the conditions of the time and making it work.

In 1691 he got together a group of prominent merchants, proposing to found a bank on the Dutch model specifically to lend money to the king and government to finance the war with France. He also took the lead in persuading the Treasury to let it happen and recruiting the investors.9 Initially rejected by Parliament, a refined plan, largely written by Paterson and pushed by him with dogged persistence, won approval three years later and the Bank of England was born. It had a Royal Charter and its sponsors, including Paterson, who was also a director, undertook to raise £1,200,000 and lend it to the Government in perpetuity at an annual interest rate of 8 per cent. In fact most of this money was not raised in coin, or gold or silver, but in bills of exchange – promises to pay – which were passed to the Government which then used them to pay its bills.10 Interest was thus being earned on money which physically did not exist. The alchemy had begun.

Paterson may have been the genius behind the Bank, but it did not bring him either the recognition or the wealth that he had hoped. His claim to be paid for all the work he had done in devising and promoting the Bank was rejected by his fellow directors. His less attractive characteristics were not long in asserting themselves and the following year he fell out with the board over a rival scheme he was also promoting. He sold his stock and left London.

If this was a setback, it did not last long. Paterson had another scheme and he set about pursuing it with vigour. Scotland had long envied the success of the East India Company, which had acquired from the English Parliament lucrative monopolies on trade with England’s colonies. Paterson proposed a similar concern north of the border, a ‘Company of Scotland’ and in June 1695 used his considerable powers of persuasion to convince the Scottish Parliament to pass the legislation allowing him to set one up. Since Scotland, unlike England, did not possess colonies, Paterson proposed to found one at Darien on the isthmus of Panama where, by means of an overland route, it would be able to link the trades of the Atlantic and Pacific.

Meanwhile Paterson’s success with the Bank of England had not gone unremarked among Scots merchants in London and Scotland. A group of them got together to propose a Bank of Scotland and the man to whom they turned to make it happen was an Englishman, John Holland.

Holland was very different from Paterson in both upbringing and temperament. Where Paterson was a visionary, impulsive and devious, Holland appears to have been the opposite, diligent, meticulous and straightforward. He had been born in London, the son of a sea captain who had served in both the English and the Dutch navies and was a sometime friend of Samuel Pepys. As a young man, John had spent time in the Netherlands learning bookkeeping and accounting, before returning to London as assistant to the Dutchman Francis Beyer, auditor general of the East India Company. He also made his fortune by investing in some of the company’s voyages.11 Beyer supported the plan for a Bank of Scotland and was one of the original subscribers. It is likely that he recommended John Holland, who drew up the plan for the new bank, taking the Royal Charter of the Bank of England as his model.

Paterson was furious. Although his public plan for the Darien Company (as his new venture became known) was to establish a colony and engage in trade, he also secretly intended it to be a bank and he urged his supporters in Scotland to lobby against the potential new rival. They failed and on 17 July – less than three weeks after Paterson got his Act establishing the Company of Scotland – the Scottish Parliament passed an ‘Act for Erecting a Public Bank’. Paterson cursed that the Act had been ‘surreptitiously gained and which may be of great prejudice, but is never like to be of any matter of good neither to us, nor those that have it’.12 Nevertheless, Bank of Scotland was born, with John Holland as its first Governor.

Although the new institution had been inspired by the Bank of England, it was to be a very different business. Whereas the London bank lent only to the government, the Edinburgh bank was to lend only to the private sector – landowners, merchants, traders and manufacturers – in fact its charter prevented it from lending to the state. It was thus Britain’s first commercial bank. The Scottish Parliament had granted it some very special and valuable privileges. It was to be incorporated with limited liability, meaning that its shareholders could not be held responsible for its debts, and for its first 21 years its dividends were to be tax-free and it was to enjoy a monopoly over banking in Scotland.

The Bank had first to raise its capital, £1,200,000 like the Bank of England, but since Bank of Scotland’s capital was to be in Scots pounds and the exchange rate was £1 sterling to £12 Scots, it would be a much smaller enterprise than its older sister. A subscription book was opened in the Cross Keys Tavern, in a close off Edinburgh’s High Street, and another in London. The Bank’s shareholders, quaintly called ‘Adventurers’, were only asked to put up an initial tenth of the capital, although in the ensuing turbulent years they would be asked to put their hands in their pockets again. Of the 172 people – including seven women – who were the Bank’s subscribers, three-quarters lived in Scotland and comprised the great and the good – landowners, lawyers and judges, merchants, nobles and government ministers and officials. The Act of Parliament also specified that any non-Scottish subscriber was to be given automatic Scottish citizenship. The Bank opened for business on New Year’s Day 1696.13

Since there were no precedents for a bank of this type, the directors and proprietors of the Bank had to make up the rules as they went along. From the start their Presbyterian rectitude asserted itself. Although John Holland was Governor and manager, he was not to be allowed to decide loan applications on his own. A committee was set up – and there were to be similar committees in branches when they were opened – consisting of men of ‘Credit and Substance’ who would decide each application by ballot – the first-ever credit committee. A cashier would look after the money, but there was also to be an ‘Overseer’ to watch over him, effectively an auditor. The directors intended to keep a very close eye on the day-to-day running of the company and their sanction was needed to increase salaries or to sack staff, a restriction which remained in force for 200 years.14

Holland invented some very prudent rules. The Bank would make money by lending, but its advances were to be made on a very cautious basis. Loans were for a maximum of one year and could be recalled by the Bank at 30 days’ notice. They all had to be backed by collateral, in the form of land, a personal security or pledges of ‘non-perishable commodities’. In the case of personal security, the Bank not only demanded the ability to seize the borrower’s ‘moveables’ in the event of a default, but also insisted on having two ‘cautioners’ to act as guarantors. It would also take deposits and, crucially, would issue its own banknotes – promises to pay the bearer on demand the face value of the note in coin.

The Bank rented a head office in Edinburgh’s High Street and branches were quickly established in other major Scottish commercial centres. In June Holland returned to London with the thanks of the directors for getting the Bank up and running. He had been paying his own expenses while living in Edinburgh and drawing no salary, his remuneration being set at ten per cent of the Bank’s profit after the Adventurers had taken a 12 per cent dividend. Since the bank was in no position to pay a dividend in 1696, he must have received nothing.

No sooner had he gone than Paterson struck. Using his considerable powers of persuasion and unrivalled contacts, he had been phenomenally successful in raising capital for his Darien Company, amassing pledges of £400,000 sterling, a sum which dwarfed the nominal capital of the Bank, which at that time stood at a quarter of that figure, and of which only a puny £10,000 sterling had been subscribed in cash.15 Organising and equipping an expedition to Panama would take time, but in the meantime Paterson intended to put his funds to profitable use.

From offices on the opposite side of Edinburgh’s High Street from the Bank, he began making loans and issuing notes, ignoring the monopoly given by Parliament to Bank of Scotland. There was concern as the Darien Company began lending to many of the people the Bank had regarded as its natural customers. Rumours began to circulate about the Bank’s stability and its notes were being presented for payment in cash in large quantities, straining the Bank’s reserves. The directors were in no doubt who was behind these moves and wrote in alarm to Holland: ‘We understand that there are formed designs to break us.’16 Holland tried to broker a peace and met Paterson, who rejected any compromise.

For a while it looked as though the Bank might go under before it had really got started. The Darien Company itself had acquired large amounts of Bank of Scotland notes and might at any time present them for payment, precipitating a collapse. Holland initiated emergency action. Branches were ordered to return as much cash as possible to Edinburgh, the Bank began to call in its loans and demanded that its subscribers stump up a further 20 per cent of the authorised capital, precipitating a dispute between the Scots shareholders, who paid up promptly, and the Londoners, who were more reluctant. Even so the Bank came perilously close to running out of cash and was itself forced to borrow.17

This was effectively the first run on a bank in British history and the directors of Bank of Scotland learned one of the fundamental lessons of banking: always ensure you do not run out of cash.

But before the crisis came to a head Paterson dropped his campaign. His shareholders had put their money behind an ambitious and romantic vision to propel Scotland from parochialism into the first rank of global powers. Paterson himself had sold it to them with poetic descriptions of Scotland one day controlling ‘the keys of the Indies and the doors of the world’. Lending money to each other was not part of the dream and, it transpired, a lot of the lending done by the Darien Company was to its own shareholders. Worse than that, the running of the company was inefficient, there had been embezzlement of some of the funds and the lending decisions it had made were poor. The company had trouble in getting its loans repaid on time and bad debts began to mount.

Paterson had learned another fundamental lesson: make sure the people to whom you lend have the means to repay you.

By this time he had unveiled his vision of a colony at Darien to the directors of the Company of Scotland and put all his energies into making it a reality. The banking business was soon forgotten.